Navigating the turbulence

This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on April 20, 2020 - April 26, 2020.

Commodity prices and credit issuers will be impacted indirectly as the MCO or lockdown implemented in various countries will further impact the general economy via a reduction in consumption and disruptions to business operations. Small businesses and daily-wage workers will be affected the most due to cash-flow disruptions. > Lee

We had muted earnings growth expectations for Malaysia at the start of the year, expecting a mild single digit ... We now expect corporate earnings growth to be -10% to -30%. > Gan

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The global economy is in a state of near paralysis. The stringent measures taken by governments to contain the Covid-19 pandemic are likely to trigger a recession not seen since the 2008 global financial crisis. Investors who have directly or indirectly invested in financial markets must brace themselves for tough times ahead, yet take advantage of the pockets of opportunities that appear along the way.

Gan Eng Peng, director  of equity strategies and advisory at Affin Hwang Asset Management Bhd (AHAM), says that although the global GDP numbers have not been published yet, the world economy is likely to be in a recession already. “We should be in a global recession already. How quickly the coronavirus can be contained will determine how long we will stay in a recession. It will also determine whether the market will stage a quick recovery or experience a prolonged downturn, with a myriad of secondary knock-on effects.”

He adds that the spread of Covid-19, if left unchecked, could double in five days based on available data. The infection rate could increase sixfold in 10 to 15 days. This has stopped people from moving around and conducting economic activities despite the fiscal stimulus and monetary policies implemented by various governments and central banks.

“The choice for governments across the world is clear. They either face a situation where a large swath of the population is infected and its healthcare system is overwhelmed or introduce some sort of lockdown. Monetary policies and fiscal stimulus were already implemented near their maximum capacity [after the 2008 global financial crisis] and they are now at the maximum,” says Gan.

“However, it is hard to foresee people being incentivised into conducting more economic activities when their health is at risk. Hence, there is a hard stop to economic activities globally, which has led to the fastest global recession and market correction we have ever seen.

“Meanwhile, we are waiting for the ripple effects of such a sharp downturn to hit businesses. It will surely happen with many entities caught off guard.”

On April 9, International Monetary Fund managing director Kristalina Georgieva said the IMF was expecting the deepest recession since the Great Depression. She projects that more than 170 countries will see negative per capita income growth this year.

Nevertheless, fund managers believe that the stimulus packages of various governments and central banks should help the global economy to rebound in the second half of this year or early next year. Whether the recovery will be a V-shaped or U-shaped one will depend on how quickly the pandemic can be contained.

Dr Tan Chong Koay, founder and chief strategist at Pheim Asset Management Sdn Bhd, is hopeful that a recovery will happen in the second half of this year. “Many governments and central banks have started to inject more fiscal stimulus into their respective economies to help companies and people affected by the pandemic. It is still too early to know when the recovery will happen and whether the stock market will have a sharp V-shaped recovery. However, we hope that a recovery will take place in the second half of the year,” he says.

Lee Sook Yee, chief investment officer at Kenanga Investors Bhd, concurs. She says the global economy is expected to contract in the first half of this year and recover in the second half, fuelled by the unprecedented levels of monetary and fiscal support globally.

However, Francis Eng, chief investment officer at UOB Asset Management Bhd, says the global economy will only experience a rebound in 2021. “The IMF predicts a short and sharp recession for the global economy in 2020 due to the impact of Covid-19. However, the combination of fiscal stimulus and monetary policies implemented by governments are expected to set the global economy for a strong rebound next year once the pandemic is behind us.”

Jason Chong, CEO of Manulife Investment Management (M) Bhd, highlights the magnitude of the response of some central banks and governments. In the US, for instance, President Donald Trump signed a US$2 trillion stimulus package last month to resuscitate the economy while the Federal Reserve cut interest rates by a whopping 175 basis points (bps) to a range of between 0% and 0.25%.

“Meanwhile, the US, Australia and Japan embarked on some form of quantitative easing and bond-buying programme. These coordinated stimulus measures are to keep the economy and financial system stable and tide us over during this pandemic,” says Chong.

He points out that the Malaysian government was quick to announce a stimulus package worth RM20 billion, or 1.3% of the country’s GDP, not long after the outbreak of Covid-19. On March 27, another stimulus package amounting to RM250 billion was announced.


GDP, corporate earnings to contract

The local economy and capital markets will not be spared the grim outlook. Malaysia’s GDP is expected to contract while corporate earnings growth, which has been mostly negative over the past six years, is likely to continue its decline.

The World Bank Group recently lowered Malaysia’s GDP growth target to -0.1% for 2020, a sharp reduction from its previous forecast of 4.5% made in December last year. Many local fund managers are still uncertain about the extent of the pandemic’s impact on the local economy.   

Public Mutual Bhd CEO Yeoh Kim Hong points out that the Malaysian government lowered its GDP growth forecast to a range of between 3.2% and 4.2% on Feb 27 from 4.8% in November last year. “However, the projection is likely to be revised further downwards as consumption expenditure — which is the largest component of Malaysia’s GDP — is envisaged to be severely impacted by the knock-on effects of the Movement Control Order (MCO), which began on March 18, as well as the steep fall in the local stock market,” she says.

On April 3, Bank Negara Malaysia revised its GDP growth projection to between -2% and 0.5% this year, compared with 4.3% in 2019. According to its Economic and Monetary Review 2019, the local economy will be impacted by the necessary global and domestic actions taken to contain the outbreak of Covid-19. However, the country’s growth prospects are expected to improve towards the end of this year, in line with the projected recovery in global demand and amid continued support from policy measures.

Yeoh says export growth will be dampened by a slowdown in global demand and the sudden plunge in crude oil prices will weaken the government’s fiscal position. “The government’s revenue is estimated to be reduced by RM300 million with every US$1 per barrel decline in the oil price.”

Crude oil prices falling to historic lows is another factor weighing down on the local economy as the Malaysian government derives a significant amount of its income from petroleum-related products.

According to a CNBC report, Brent crude oil dropped to US$23.03 per barrel on March 30 — its lowest level in 17 years. This was mainly due to the price war between Saudi Arabia and Russia as they had failed to agree on the terms of a supply cut at a recent meeting between the Organisation of the Petroleum Exporting Countries (Opec) and its allies. The slowdown in the global economy also contributed to the price decline.

On April 12, the parties finally reached a deal to cut output by nearly 10%. Brent crude oil was trading at US$31.27 per barrel on that day.

In an April 13 note, AHAM deputy managing director and chief investment officer David Ng said the planned production cut was unlikely to be sufficient due to demand destruction and may not push oil prices back to their previous highs. “The Covid-19 pandemic has sapped demand by 20 million to 30 million barrels a day. At most, the supply cut would be enough to provide a floor or support level for oil prices to range between US$30 and US$40 per barrel this year. It will be important to see a peak in infection levels and economic activities normalising for demand to return.”

Political instability is also weighing down on Malaysia’s economic growth. Doreen Choo, chief investment officer at Eastspring Investments Bhd, says the unexpected change in government last month without the need to go through an election process has invited uncertainty and introduced heightened political risk in the country. “Market sentiment was already poor at the time with the Covid-19 outbreak in China. Investors, including foreign investors, are concerned that the reform agenda [introduced by the previous government] will take a backseat. They are worried that the country’s economic growth may be impacted as investment decisions by businesses are put on hold due to growing policy uncertainties.

“Foreign investors were net sellers of Malaysian equities for the past two years to the tune of RM22 billion. We expect most foreign investors to underweight Malaysia for now. Unlike the risk posed by Covid-19, which is seen as a shorter-term one, political risk can drag the market further given the risk premium, especially when the new coalition is made up of parties with very different philosophies.”

Roszali Ramlee, CEO and managing director of AmanahRaya Investment Management Sdn Bhd, remains hopeful that the local economy may not be as badly hit as other economies in the region. “Initially, we were looking at a GDP growth of about 4% for the local economy this year. Now, we are looking at -2% to -4.5%, depending on the duration of the MCO. Previously, our economy was well supported by consumer spending, which provided a steady 2% GDP growth base. But with Covid-19, this hangs in the balance,” he says.

“The good news is that the stimulus efforts by the government are consumer-focused. We think that these, coupled with the low interest rate environment, will create pent-up demand when the economy reopens.”

Market players are expecting corporate earnings to see negative growth this year. At the beginning of the year, Kenanga Investors’ Lee expected the FBM KLCI’s earnings growth for 2020 to be in the mid single digit, driven by higher earnings from plantation companies and banks. But she changed her views after the outbreak of Covid-19.

“Following the outbreak, crude palm oil prices have retreated sharply to about RM2,200 per tonne on lower demand. Meanwhile, the earnings of banks will be affected by lower net interest margins after Bank Negara Malaysia unexpectedly cut its overnight policy rate (OPR) twice to 2.5%,” she says.

“Consensus is expecting the central bank to cut the OPR by another 25bps to 50bps to counter the downside risk from Covid-19. The additional interest rate cut will further pressure the earnings of banks. In view of the potential earnings downgrade for both sectors, we no longer expect positive FBM KLCI earnings growth in 2020.”

AHAM’s Gan has revised his 2020 corporate earnings growth forecast to negative from positive at the beginning of the year. “We had muted earnings growth expectations for Malaysia at the start of the year, expecting a mild single digit. However, that was derailed first by a change in government, followed by the Covid-19 outbreak and then the plunge in crude oil prices. We now expect corporate earnings growth to be -10% to -30%,” he says.

“We think the effects of Covid-19 will linger. Even if there is a quick recovery by the summer months, the effects will continue to impact the country’s economy for 9 to 12 months. Hence, we are expecting negative earnings growth with the market direction down for the rest of the year.”

Principal Asset Management Bhd CEO Munirah Khairuddin also expects negative earnings growth this year. “We started the year with expectations of an earnings per share growth of 4%. However, the markets have now priced in negative growth with the current fear of the Covid-19 pandemic,” she says.  

Corporate earnings could decline this year although it is too early to conclude on the magnitude of the decline, says UOB Asset Management’s Eng. “In previous recessions or crises since the 1970s, global earnings declined by about one-third on average.”


Fund houses raise cash, invest selectively

The fast-declining economic conditions have weighed on equity markets around the world. As at April 9, the S&P 500 had fallen 13.64% year to date while the FTSE 100 had plunged 22.54%.

As at April 10, the Nikkei 225 and Shanghai Composite Index had slipped 16% and 8.66% year to date respectively. The FBM KLCI slid 14.55% while the FBM Emas Index, which represents the broader market, plunged 17% during this period.  

Due to the heightened market volatility and downward trend, some fund houses have taken incrementally more defensive positions.

“We remain cautious and continue to stay prudent until we have the conviction that the Covid-19 infection rate can slow down and its secondary effect that causes the market crash is known. We are expecting negative returns for this year,” says AHAM’s Gan.

Kenanga Investors’ Lee says its investment team is maintaining a higher than average level of cash for now in the light of its defensive positioning. “This translates into about 15% on average, which we are ready to deploy on further market pullback.”

Public Mutual’s Yeoh says the firm’s equity funds have generally reduced their exposure and raised their cash levels in response to the developments unfolding in financial markets.

While the pandemic has badly affected stocks across the board, businesses that have been harder hit include highly geared companies as credit becomes harder to come by. Small-cap counters have suffered as well, partly due to a lack of liquidity, says Gan.

He expects oil and gas companies, banks, travel-related businesses and retailers to suffer going forward. “Oil and gas players could see further weakness, given the [recent] geopolitical fight and reduction in demand. Credit providers may perform poorly, given the stress of lending. Further weakness could also be seen in businesses related to travel and retail,” he says.

Lee does not favour commodities in general. “Commodity prices and credit issuers will be impacted indirectly as the MCO or lockdown implemented in various countries will further impact the general economy via a reduction in consumption and disruptions to business operations. Small businesses and daily-wage workers will be affected the most due to cash-flow disruptions,” she says.

“Indirectly, this will translate into weaker commodity prices and potentially cause credit issues. The global economy is a highly interlinked system with multiple feedback loops [so what happens overseas will impact local businesses].”

Over the longer term, several sectors could perform well. Several fund managers favour companies that can tap into growing technology trends such as e-commerce, 5G and the Internet of Things.

Areca Capital Sdn Bhd CEO Danny Wong says the technology trend is expected to gain more traction going forward despite the current economic turmoil. “In this environment, we like future-proof investment themes such as 5G and technology [as a whole]. We also like stocks with attractive and sustainable yields.”

Yeoh has a long-term positive view on stocks that can ride the technology trend. “Technology, e-commerce and social media stocks are favoured due to their long-term structural growth prospects,” she says.

Fund managers also like the healthcare sector for its more resilient earnings and stronger financial positions. While some investors stay away from the banking and oil and gas sectors, fund managers have a different view.

Ahmad Najib Nazlan, executive director and CEO of Maybank Asset Management Sdn Bhd, favours banks despite their poor performance in the first quarter of this year. “We expect to see a recovery [in banking stocks] as pressures on their net interest margins are expected to taper off while credit costs are stabilising. Furthermore, Bank Negara has provided the sector with support by reducing the statutory reserve requirement by 1% to 2% recently. The sector is trading at a low valuation with attractive dividend yields, which present an attractive investment opportunity,” he says.

Meanwhile, the oil and gas sector is well positioned to capitalise on any upturn in oil prices and business activity despite the recent plunge in crude oil prices, says Ahmad Najib. “We have reduced our weightage on the oil and gas sector in the current quarter [2Q2020]. However, the sector could benefit from any upside going forward, given the recent sell-off. Oil and gas companies have recapitalised their balance sheets and undertaken impairment of assets since the last downturn in 2015.”

RHB Asset Management Sdn Bhd managing director Eliza Ong says the firm is looking to buy counters that could benefit from the weakness in the ringgit. “We are looking to buy export-related stocks that may benefit from the expectation of a weaker ringgit. These include manufacturing companies that may benefit from the reallocation of orders from China.

“We are also looking at companies with strong cash flow supported by a solid management team. These are also companies that have invested sufficiently in technology as it will enable them to weather the storm caused by Covid-19.”


Equities or bonds?

Amid the harsh economic conditions, some fund houses are overweight on equities while others prefer bonds. Kenanga Investors’ Lee says that from a portfolio perspective, the firm continues to overweight stocks as the sharp fall in share prices has resulted in attractive valuations.

“We continue to be neutral on bonds as yields were trading at unprecedentedly low levels for the most part of 2019 and until March this year. That is despite the risk aversion of investors of late, which has seen some unwinding of bond trades, which brought bond yields back up.”

Public Mutual’s Yeoh says equities are attractive as the dividend yield of some counters are now higher than 10-year government bonds. “This yield differential increases the appeal of stocks on a longer-term basis. This will benefit investors with a higher risk tolerance and who are seeking long-term capital growth.”

Equities have a more attractive upside over the longer term, says Areca’s Wong. “As long-term investors, we believe that the risk-return trade-off is skewed more towards equities. We will accumulate stocks that we like whenever we see value in the market.”

Meanwhile, Maybank Asset Management’s Ahmad Najib sees more value in bonds as yields remain attractive and this asset class is more defensive than equities. “Also historically, during the 2008 global financial crisis and 1997/98 Asian financial crisis, there was a sharp selldown in the bond market. Subsequently, when there were signs of an economic recovery, it would see an immediate V-shaped recovery,” he says.

AmanahRaya Investment Management’s Roszali has a similar view. “We have remained overweight on bonds and kept our equity exposure minimal for a couple of years. This asset allocation strategy has panned out well for us. We currently do not see a compelling reason to change our asset allocation,” he says.

“While the recent market correction has made equities look attractive from a valuation standpoint, the returns provided by bonds are still very good. Bonds also offer a far better return-volatility ratio than equities.”

While UOB Asset Management’s Eng favours bonds over stocks at the moment, he expects his outlook to change in the coming months. “In the near term, the outlook for bonds is more favourable as the asset class benefits from an aggressive monetary easing policy and rising risk aversion sentiment. However, in the coming months, we expect to turn more positive on equities as the sharp market decline presents buying opportunities. The catalysts for equities to outperform include the peaking of Covid-19 and governments undertaking more fiscal stimulus, especially the US,” he says.